Scapegoating Fannie and Freddie - the New Republican Orthodoxy

You have to be blind, dumb, or maliciously misleading to miss the contribution of Wall Street to the housing bubble and the financial crisis.

By Numerian posted by Michael Collins

Yesterday the four Republican members of the 10-member Financial Crisis Inquiry Commission issued their own report on what caused the credit crisis of 2008-2009. They did this because they wanted to put down a “marker” on what they think happened to the markets and the economy, before the whole commission releases its official report next month. Many observers say this unusual move will damage the credibility of the official report, and reflects yet again the bitter partisan struggle that is taking place in Washington between Republicans and Democrats.

This is not a partisan political struggle going on here, at least not for the most part. Enough Democrats on the Commission have spoken up that we see what is really happening. The Democrats who run the Commission are using fact-based arguments and reality-based research to determine what happened during the financial crisis. The Republican minority members are all theologians using a faith-based approach that says government is evil and fundamentally at fault here, the market is all-pure and all-wise, and the “financial industry” is certainly not to blame.

As reported by one of the Democratic Commission members, Brooksley Born, the Republicans demanded but failed to get the Commission to remove all references in the final report to “Wall Street” and “shadow banking”. Sure enough, you will not find these phrases in the Republican 13-page document issued yesterday, which is a fantasy statement that complies with Republican theology on the markets, but conforms very little to a realistic view of what happened during the credit crisis. We should definitely pay attention to the Republican statement, not for what it says about the financial crisis, but for what it says about the state of the Republican Party.

It All Began With Bill Clinton

Under the heading How did the U.S. government contribute to declining lending standards?, the Republican members of the Commission finger their culprit for the financial crisis – Fannie Mae and Freddie Mac. The Republicans argue that these two Government Sponsored Enterprises, through their practice of buying and insuring trillions of dollars of mortgages and mortgaged-backed securities, created the housing bubble. They then made things much worse, ensuring that a financial crisis would ensue, by lowering their credit standards to include sub-prime mortgages for financially weak borrowers in their portfolios. All of this was done because the government, starting with Bill Clinton but including George W. Bush, wanted to increase home ownership among poor people, and anytime government interferes with the economy or the markets in a big way, bad things happen. Anyone who knows anything about Fannie Mae and Freddie Mac knows that they were favorite creatures of Democratic politicians, and by highlighting them as the principal cause of the financial crisis, the Republicans are clearly laying blame on Bill Clinton and the Democrats.

We don’t know what the final Commission report will say, but Fannie Mae and Freddie Mac certainly deserve criticism for jump-starting the housing bubble. In the early 1990s, the two GSEs began to expand their balance sheets significantly, ultimately buying or guaranteeing over $6 trillion in retail mortgages. They became quasi-central banks in the process, since every mortgage they bought or guaranteed involved the creation of credit. The Federal Reserve sat back quietly, refusing to stop these rivals from inflating a housing bubble (the Fed could have crimped the whole campaign if it clamped down on bank lending), but every so often the Fed reminded Congress that this could end very badly.

What the Republicans decline to acknowledge is that the GSEs had grave difficulty hedging their mortgage portfolios, and eventually their regulator was forced to shut them down in 2004 for several years until they got their accounting records in order. This was a crucial moment in the housing bubble. Without the GSEs buying and guaranteeing mortgages, the whole market would have slowed down considerably and the housing bubble, once it began to collapse, would have been much less damaging. Instead, “the market” took a different turn, by turning to investors around the world to buy mortgages, thus replacing the GSEs.

And just who was this “market” that supplanted Fannie Mae and Freddie Mac? You can count the actors pretty much on two hands: Goldman Sachs, Merrill Lynch, Morgan Stanley, Lehman Brothers, and Bear Stearns, all of which were investment banks, and JP Morgan Chase, Bank of America, Citigroup, and Wells Fargo, which were commercial banks. The first group was not regulated by the Fed, while the commercial banks were. Collectively they were known as “Wall Street”, because the business of Wall Street has always been bringing securities to market.

These were the players, plus a few banks from overseas, that bought up mortgages in a feeding frenzy, and they did so with no credit standards whatsoever. Whereas Fannie Mae and Freddie Mac had minimum deposit requirements and homeowner credit checks necessary to buy or guarantee a mortgage, Wall Street had nothing and didn’t care about it – the paper was sold instantly to guileless investors anxious for a little bit better yield than they were getting on government securities. This was the era of NINJA loans – no income, no job, and no assets required - or as industry observers said at the time, anyone who could breathe into a mirror qualified for a mortgage.

If you do a quick check of the mortgages which have caused by far the greatest losses in the financial crisis, it is the 2004 – 2007 vintage of NINJA loans. The Fannie Mae and Freddie Mac loans have held up much better, though the losses on these mortgages have still been significant. Note too that when Fannie and Freddie got back into the mortgage business in 2007, they felt they had to catch up to the market and they began buying securities with NINJA loans. These securities caused enormous losses for the GSEs and helped push them into receivership and the hands of the government to be rescued, but this was the tail end of the housing bubble. At the height of the bubble, it was Wall Street which destroyed what was left of credit standards in the housing market.

What About the Shadow Banking System?

You have to be blind, dumb, or maliciously misleading to miss the contribution of Wall Street to the housing bubble and the financial crisis. The Republicans compound their damage by denying that something called the shadow banking system even existed.

It was the shadow banking system which collapsed in the financial crisis, and the whole bank rescue program by the Federal Reserve, which we now know involved at least $3 trillion of loans to the remaining financial institutions, was necessary because the Fed had to replace the shadow banking system in order for the economy to survive the shock of its demise.

What was the shadow banking system? It was, once again, Wall Street, this time usurping the role of the commercial banks in the economy, while at the same time avoiding any of the regulatory oversight or capital charges that commercial banks had to suffer. As early as the 1980s, the large Wall Street investment banks branched out of their safe world of bond and equity underwriting, for the lucrative world of trading, collecting deposits in money market accounts, running mutual funds, investing in corporations through their own hedge funds, lending billions of dollars to corporations and financial firms with short tem securities like repos, auctioning off municipal bonds, and joining in the explosive growth of the derivatives market. Most of this business involved lending money, which put the Wall Street investment banks directly in the credit business of banking, for amounts that grew to trillions of dollars of loans.

The commercial banks, seeing their franchise invaded by the investment banks, stepped up by invading the bond and equity business of the investment banks. By 1999, the barriers which separated the two industries under the Glass-Steagall Depression-era legislation, had largely disappeared, and the act was repealed by Congress. The way was open for full-scale integration of commercial banking with investment banking, except one side of the equation – the investment banks – had no credit culture or experience managing loans, and they were not heavily regulated in this area. They thought they got rid of this problem by securitizing and selling these loans to investors as quickly as possible. The commercial banks had a related problem: they didn’t have enough capital to support all the lending the brave new post-1999 world allowed. They thought they got around this problem by selling off these loans into loosely-connected subsidiaries they called Special Investment Vehicles.

Both were wrong. The financial crisis of 2008 – 2009 was as much about the collapse of the money market industry, the commercial paper market, the municipal auction market, the mortgage securitization market, the asset-backed securities market, and the bank Special Investment Vehicles, as it was about the fall in housing values. To deny this – not even to mention the existence of a shadow banking system – is to practice deceit on a grand scale, and to ignore all the evidence in front of everyone’s eyes from the behavior of the Federal Reserve once the crisis hit. The entirety of the Fed rescue program has been to replace or prop up the shadow banking system; you can look at the Fed balance sheet under its two Quantitative Easing programs to see over $2 trillion in loans taken on as a consequence.

This is just part of the deceit perpetrated by the Republican Commission members. There is no mention of Alan Greenspan and the Fed’s dangerous policy of ultra-low interest rates in 2001-2002, of the Fed’s refusal to clamp down on NINJA loans being booked or bought by commercial banks, of why and how the rating agencies badly misread the risk in mortgage-backed and other securities, of the role of derivatives (other than a passing reference to CDOs) and the failure of Wall Street to develop a robust pricing model for these instruments, of the mounting evidence of outright and prevalent fraud in the solicitation, booking, documentation, and securitization processes for mortgages, of the continuing use of fraud by banks in foreclosing on homes, of the egregious conflicts of interest Wall Street had when it shorted the very securities it was selling to its customers, of the fines Goldman Sachs has had to pay as a result of such behavior, of the existence of housing bubbles all around the world, or of the global systemic risk that tied large banks together, making them Too Big To Fail.

What motivates Republicans to act in this way?

The Theology of Market Perfection

The Republicans who sit on the Commission are men like Bill Thomas, a former Republican Congressman, and Douglas Holtz-Eakin, head of the Congressional Budget Office under George W. Bush. Their familiarity with the financial industry comes from meeting with bank executives or industry lobbyists, not from meeting with community activists. They are acutely aware of the financial support the party receives from the financial industry. They have spent their entire careers steeped in the Republican worship of the financial markets, which according to conservative orthodoxy are the only fair arbiters of society’s wealth. Government, on the other hand, is the problem, not the solution, as the revered Ronald Reagan said.

The narrative that the GSEs are the source of all the financial problems began with Republican intellectuals like Rush Limbaugh and Sean Hannity, but it dovetails nicely with economic orthodoxy. People like Thomas, Holtz-Eakin, or the other Republican Commissioners have no problem espousing this dogma and applying it to the problem of assigning blame for the financial crisis. Whether they believe in the Republican orthodoxy or not, they cannot in their professional lives abandon it. To do so would be like a Creationist accepting the fact that the earth is about 4.5 billion years old.

The “market”, therefore, cannot be blamed for this crisis because it has no imperfections to speak of. Neither do the practitioners of the financial arts, such as the investment and large commercial banks, who are assigned no blame whatsoever in the Republican report (other than to say they like everyone else believed housing prices would never decline). There is no talk in their report about price imperfections or price manipulation, because again, such things cannot exist. Read your Ayn Rand to be assured on this point. And speaking of Ayn Rand, it was her acolyte Alan Greenspan who refused to allow the Fed to stamp out NINJA loans and other dangerous bank practices. While he has since expressed disappointment in learning that bank self-interest could cause such damage to the economy, he has not abandoned the movement theology at all.

Democrats on the panel apparently spent most of the summer negotiating with the Republicans over conclusions and wording in the final report, only to realize that no agreement was possible. They did not comprehend they weren’t dealing with men who valued rationality or consistency, or who respected the evidence in front of their eyes. The Republican Commissioners are theologians in the tradition of the new Republican Party, and they are every bit as rigid and dogmatic in their thinking as the evangelical Christian Republicans who equate abortion with murder. These men cannot and will not ever accept anything but the party line, even if it does originate from the likes of Rush Limbaugh.

One of the conclusions that the Democrats should come to, but which they may not print, is that a principal contributor to the financial crisis was the Republican belief in the infallibility of the markets, and the consequent dismantling of the Glass-Steagall act and any meaningful regulations over the shadow banking system.

An even better conclusion is this: there will be no economic recovery for this nation, and no way to solve our many serious problems, as long as the Republican Party exists. The Republican Party needs to die, and be replaced by a whole new political party that respects and abides by what the intellect and rational thought can adduce. The reliance on fantasy, wishful thinking, propaganda and other forms of deceit – all of which are the hallmarks of a theistic and authoritarian organization – must cease, as must the practice by certain Democrats of negotiating and “compromising” with such people as if they were principled and reasonable actors.

First published at The Agonist



not that Fannie/Freddie aren't screwed up

They have not been reformed at all, I can't recall the bail out figures at the moment, but they potentially are more than TARP, and there is no end in sight. They need to be reformed. That said, ignoring CDSes, derivatives and securitization is a direct result of the Banksters and their agenda.

This is a nice compliment to your piece

With the Republican censorship of words - "shadow banks," "Wall street" etc., we're ad DEFCON 4 on the Decadence Scale. That's simply beyond words. Wait until that story gets around. The public is in for a real shock treatment. The sad thing is that the Republican majority was a punishment of the Democrats for doing nothing. The rightists are taking this as an endorsement. Will they ever be surprised. While everyone at the top fiddles, Rome burns.

My impression, from watching the lame duck

Is the corporate agenda is going on full stream, both parties. By just giving in on the omnibus bill, they clear the way for an attack on social security again. Instead of jobs, we're streaming towards a direct attack on the middle class. Notice how the dialog doesn't even mention any other taxes, or cutting the defense budget, killing military bases overseas.

I agree, banning words like shadow banking, they are trying and I guess winning, at pushing the facts under the rug.

It is odd that your previous

It is odd that your previous 'Money Party' statements are suddenly subsumed by anti-Republican sentiment.

You failed to note the Rubin/Clinton/Geithner/Summers/Obama angle - the repeal of Glass Steagall by a Republican Congress with Clinton's assistance is as much a factor in the housing/tech bubbles as anything else.

That Fannie and Freddie were less complicit due to somewhat lower foreclosure rates is completely misleading - the lack of subprime itself would be enough to balance the perspective.

While subprime loans themselves were not the prime reason for the real estate bubble and subsequent financial crisis, they did very much skew the overall foreclosure rates.

The same could be said for 2nd mortgages or HELOCs - neither of which Fannie and Freddie engage in.

So let's not take our eye off the 'Money Party' by stooping to kabuki theatre pseudo partisanship.

Thanks for the comment

I am not the author of this piece.  It's by inernet poster Numerian.  I think it's excellent, regardless of whose ox is being gored, politically.  The private banks taking up the housing bubble banner when Fannie and Freddie were sidlined in 2004 is a great point, imho.  It was a government-private sector partnership.  Interesting how both sides of the equation were rewarded for their mistakes.  The Fannie and Freddie stories have yet to be told.  I'm looking forward to that!

Since the Obama administration began, I've laid off the Republicans since they had little power.  They are a definite threat to any form of capitalism and freedom, that's for sure.  They were simply collaborators in the damage from 2008-2010.  However, Ii've been most bipartisan in my narrative of the grand betrayal.  This piece (which I'll reference more often in the fugure) starts with Glass-Steagall and the Commodities Modernization Act, both passed during the Clinton era and signed with gusto by the former president.  See: 


I don't think anyone is denying ...

that the Democrats have blood on their hands so to speak .. more so President Clinton and the Senate(out of 100 .. only 8 voted against the repeal of Glass-Steagall) .. the problem is no one(those who get on TV all the time) wants to stand up to Wall Street .. where we find more people like Bernie Sanders? I don't know.

The American Von Hindenberg

Cutting the payroll tax from to 4.2% is quite a big deal. Social Security is defunded. The 7.2% will not come back in a Presidential Election Cycle. To understand the attack on public pensions fully, we need to take a loner view of public pensions. The deal is absolutely not compromise, Obama caved, McConnell won.

Something very rare in modern (post 1500) history on Thursday. The forces of anti-compromise triumphed on the American political scene. The consequences of destruction of 150 years of reform from Bismark to FDR are impossible to exaggerate.
In the U.S. and around the globe, all public pensions are being systematically gutted. In the U.S., the forces are Darkness are truly on horseback.

Let's simplify a big piece of history and observe that the modern state in present form, survived because of the reforms designed to thwart it's most vocal usurpers. FDR told all who would listen that he did not want other Huey Longs or Minnesota Farmer Labor Party to sieze more state governments. FDR started the move to Social Security with reform and counter revolution in mind, just like Bismark.

In Europe of the 1870s, the reformers who created the public pensions never denied the motive of stopping the Socialists and especially the Paris Commune of 1870. Public Pensions in Germany are the product of Bismark and Metternick who created pensions to stop revolutions. History is straightforward about the motives of public pension reformers.

When Social Security is defunded, we go back to the days of Orphan Annie and Daddy Warbucks, alms houses and orphanages, a world that's the wet dream of the reactionary plutocrat. Daddy Warbucks got his tax cuts and we are moving into a very dark age.

Let's look at the A-List of history's No-Compromise guys. Top of the list is Oliver Cromwell. Architect of the Puritan Revolution just did not budge and it got him the position of Brittain's only dictator and a reign of terror exceeding even Richard III.

Next without doubt is Robbespiere, when Neccar and the the Grand Compromise failed in June of 1789, the French Revolution followed in July. Neccar pleaded with Louis XV
to return to the democratic constitution of 1614 and an Assemblee Nationale. The result of the failure of compromise was kind of a big deal. Robbespiere blunted every move toward compromise and used all of Louis XV blunders to his advantage.

Lenin was the kind of guy who could take over any meeting or board room. The agents of Kaiser Wilhelm knew what they were doing when he was sent back to Russia. In the Duma in 1917, Lenin allowed no deals, undermined Kerinsky in every turn and played out his hand perfectly in street theater.

Lenin's best student A. Hitler wrote his Mein Kampf giving Lenin huge credit. So when the election of 1933 was stalemated, the National Socialsts never waivered and never gave in to the Communists. It fell to the Chirstian Democrats, von Hindenberg to throw in with the National Socialists and annoint Hitler.

So now we come to our own Von Hidenberg, advised by the great sage of the Democratic Party, William Jefferson Clinton, who gave us Graham-Leach, NAFTA, Health Scare. Our Von Hindenberg has handed us over to the forces of darkness.

History by the same token has happy outcomes, like Christian V of Denmark, George Washington and famously Cincinnatus in ancient Rome. Each of these men believed in good government and put the nation above personal ambition to the point of sacrificing all political power for the sake of the republic.

Michael Collins: I am not the

Michael Collins: I am not the author of this piece.

Fair enough. As I noted, it seemed strange compared to your previous posts.

Michael Collins: I think it's excellent, regardless of whose ox is being gored, politically.

The facts are indubitably true, but the message is obscured by its rabid anti-Republican partisanship.

I also note that the article in question focuses on ridiculous things like the 'shadow banking' and 'Wall Street' redaction.

The real problems are systemic fraud - it would be far more productive to rail against the combination of a complete lack of prosecution (not a single indictment has yet occurred over MBS/mortgage/ratings agency/appraisal fraud) and subsidies for home ownership.

In these two areas - the Republicans are no better nor worse than their Democrat counterparts.

For every Bachus, there is a Barney Frank.

Another premise of the article is also false: that somehow the GSE's are blameless in the housing debacle.

This is patently untrue. The very existence of Fannie and Freddie - drafting behind the 'full faith and credit of the sovereign United States' - was very much a factor in the housing bubble and subsequent collapse.

The supposed replacement of the role of the GSE's by shadow banking is a complete fantasy - Fannie and Freddie loan portfolios grew steadily throughout the 2002-2007 period.

Equally so, the supposed cleanliness of Fannie and Freddie loans from NINJAs is also a fantasy. The GSEs went into receivership in September 2008 - simply insufficient time for large numbers of 'good credit' loans to sour due to unemployment and/or housing price falls.

Both GSEs were suffering losses long before their receivership - even in the tail end of the housing bubble.

Once again, the over-focus on both rabid partisanship and largely irrelevant but hot button issues obscures what really happened and what really needs to happen.